Statement 4: Fiscal Policy and Economic Growth

The COVID-19 pandemic is an unprecedented shock. With conventional monetary policy curtailed, the Government is providing significant support to households and businesses. By replacing lost incomes for households, keeping businesses afloat and maintaining links between employees and employers, this support has significantly reduced the decline in output and employment and will mitigate economic scarring from the crisis. Payments have increased rapidly but are expected to decline from their 2020-21 peak as the economy recovers and temporary measures are scaled back. However, Australia’s economy will be persistently smaller as a result of the COVID-19 pandemic, relative to previous forecasts, meaning that spending as a share of GDP will be higher than previously projected across the medium term. In addition, consistent with previous shocks, receipts are likely to take longer to recover than economic activity. As a result, budget deficits are projected across the medium term. Net debt is projected to peak at 43.8 per cent of GDP at 30 June 2024 and fall to 39.6 per cent by the end of the medium term. The increase in debt is necessary to respond to the pandemic. Australia’s debt-to-GDP ratio will remain low compared with most advanced economies. In addition, low interest rates make debt easier to service. With stronger growth and responsible fiscal management, it will be easier to stabilise and begin to reduce debt as a share of GDP, even before budget surpluses can be achieved. The Government has set out a revised Economic and Fiscal Strategy in response to the COVID-19 pandemic. The previous strategy was to achieve budget surpluses, on average, over the course of the economic cycle. The Government’s objective was to deliver surpluses of sufficient size to significantly reduce gross debt and eliminate net debt by the end of the medium term. The previous strategy is no longer appropriate in the current economic and fiscal circumstances.The revised Economic and Fiscal Strategy supports the Government’s objective of achieving a strong economy through sustainable private sector-led growth and job creation, underpinned by a strong government balance sheet. The first phase of the Strategy — the COVID-19 Economic Recovery Plan — is focused on achieving a strong recovery to drive down the unemployment rate. The Government will continue to provide temporary, proportionate and targeted support to encourage job creation and investment. It will also implement supply-side reforms to make the economy more flexible and productive.

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In the second phase, once the economic recovery is assured and the unemployment rate is comfortably back under 6 per cent, the focus will shift to stabilising and then reducing debt over time as a share of GDP, while continuing to push ahead with reforms to lift economic growth. The JobMaker Plan is a core element of the Government’s COVID-19 Economic Recovery Plan. It will support Australians through the COVID-19 pandemic while also delivering a more flexible and dynamic economy. By creating a stronger and more flexible economy, Australia will achieve the longer-term growth needed to reduce debt and build prosperity.

Contents

Australia’s fiscal response to COVID-19..............................

Implications of COVID-19 for the fiscal outlook..................

Fiscal sustainability after COVID-19..................................

Revised Economic and Fiscal Strategy..............................

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Statement 4: Fiscal Policy and Economic Growth

Australia’s fiscal response to COVID-19The global COVID-19 pandemic is a once-in-a-century shock. The economic impact has been deeper and sharper than previous recessions in the 1980s and 1990s. Australia’s GDP declined by 7.0 per cent in the June quarter 2020, its largest fall on record, after contracting by 0.3 per cent in the March quarter, and considerable uncertainty remains around the outlook (see Budget Statement 2: Economic Outlook).

Unlike previous downturns, the current crisis is health-related. To protect the health of citizens, countries closed or restricted international borders and locked down movement and activity within their economies. The COVID-19 pandemic, and the restrictions introduced to limit its spread, are having a severe impact across the economy and changing the way people behave and businesses operate.

Also unlike previous downturns, the Reserve Bank of Australia (RBA) had less capacity to use conventional monetary policy to respond to this shock. Over the past decade, Australia’s official cash rate has gradually fallen closer to the ‘zero lower bound’, partly as interest rates globally have been pushed down by an oversupply of investable funds. This excess saving has been attributed to various factors, including population ageing, a slowing in global productivity growth and increased risk aversion in the wake of the Global Financial Crisis.

In response to the 1990s recession, the RBA cut the official cash rate target by over 10 percentage points and in response to the Global Financial Crisis it cut the cash rate by 4.25 percentage points. At the onset of the COVID-19 pandemic, the cash rate was 0.75 per cent and the RBA reduced it by 0.5 percentage points to 0.25 per cent, bringing it close to the zero lower bound.

In the absence of conventional policy space, the RBA has deployed unconventional measures to support growth and financial system stability. These include: a commitment to hold the cash rate close to the zero lower bound, a yield curve control target for the 3-year government bond yield also at 0.25 per cent, and a Term Funding Facility for the banking system.1 While these measures are providing meaningful macroeconomic support,

1 Lowe P (2020), “Statement by Philip Lowe, Governor: Monetary Policy Decision”, 19 March 2020.4-5

their stimulus effect is much less than has historically been provided by monetary policy during sharp downturns.2

This has increased the importance of fiscal policy in dealing with the COVID-19 shock and the Government has provided unprecedented levels of economic support.

The initial response to the COVID-19 pandemic provided $299 billion in overall support to keep Australians in work and businesses in business. The 2020-21 Budget includes $98 billion in additional support, including $25 billion in further measures in response to the health and economic effects of the COVID-19 pandemic and $74 billion under the JobMaker Plan to drive the economic recovery. This brings the Government’s overall support since the onset of the pandemic to $507 billion, including $257 billion in direct economic support.

The COVID-19 Economic Response PackageThe Government’s initial economic response to the pandemic was tailored to the characteristics of the crisis. The restrictions to address the health impacts of COVID-19 put large parts of the economy into hibernation and represented both a major demand and supply shock that could have led to cascading levels of unemployment and business foreclosures.

The focus of policy was to replace lost incomes for households and provide cash flow support to businesses. Given the nature of the shock, there was also a role for fiscal policy to help maintain employee-employer relationships, in order to speed up the recovery when restrictions were progressively removed.

The Government took unprecedented steps to replace business and household income lost as a result of the pandemic through measures such as the Coronavirus Supplement, which effectively doubled unemployment benefits, the JobKeeper Payment, which subsidised wages paid by organisations that suffered a sufficient decline in revenue, and cash flow assistance measures for businesses. These measures were designed to move in line with economic need, amplifying the effects of the automatic stabilisers.

Automatic stabilisers are features of the tax and transfer system that dampen the size of economic cycles without the need for explicit actions by policymakers. The Government has allowed the automatic stabilisers to operate freely to dampen the effect of the COVID-19 shock. In a downturn, household and business after-tax income falls by less than before-tax income (for instance, due to progressivity in the tax system and loss

2 Guttmann R, Lawson T and Rickards P (2020), “The Economic Effects of Low Interest Rates and Unconventional Monetary Policy”, RBA Bulletin, September 2020:21-30.

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provisions) and transfer payments increase (due to increases in unemployment benefit payments and income testing of other transfer payments). This provides an economic stimulus that can reduce the magnitude of the downturn.

The three-month review of the JobKeeper Payment found that it successfully halted the rapid employment decline that commenced in the second half of March 2020 and provided a confidence boost to employers and employees. JobKeeper has been extended from late September 2020 until late March 2021 at a reduced payment level and is subject to a reassessment of eligibility. These changes will address findings of the review that some features of the payment created adverse incentives which may become more pronounced over time, such as dampening incentives to work and hampering labour mobility.

The Government also allowed people affected by the COVID-19 pandemic to gain early access to up to $10,000 of their superannuation in 2019-20 and 2020-21 and worked with lenders to enable households and small businesses to defer loan payments. These measures also provided a substantial boost to household and business balance sheets.

As intended, economic support has had a significant effect on business and household incomes. While gross national income fell in nominal terms by 7.0 per cent in the June quarter 2020, household disposable income rose by 2.2 per cent. Treasury analysis of Australian Taxation Office Single Touch Payroll data and Household Income and Labour Dynamics of Australia data indicates that higher-income households on average saw no change in disposable income between the March and June quarters, while the average income of the lowest income households increased by 20 per cent.

The initial COVID-19 Economic Response Package was targeted at individuals with low or reduced incomes and relatively high propensities to spend. Nevertheless, it was always expected that some support would be saved or used to pay down debt due to restrictions on movement that limited opportunities for households to spend their income. Australian Bureau of Statistics (ABS) survey data provide evidence that a significant proportion of support has been spent. For example, the detailed June release of the Household Impacts of COVID-19 Survey found that only 27 per cent of households who received the $750 Economic Support Payment reported that they had mainly added it to savings. Also, some additional saving does not mean that policy support was excessive. Stronger household balance sheets are expected to be drawn on as restrictions are eased, boosting the economic recovery.

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Budget Paper No. 1

The JobMaker Plan The JobMaker Plan is a key element of the Government’s COVID-19 Economic Recovery Plan, providing for the private sector to return to driving growth in the economy. The JobMaker Plan will deliver the vital investments and reforms necessary to drive a more flexible and dynamic economy and lift Australia’s longer-term growth potential.

The immediate priority is to secure a strong and sustained economic recovery to help get Australians back into jobs as fast as possible. Young and low-skilled workers have seen the largest increases in unemployment during this recession. Getting people back into work quickly is the key to avoiding long-term disadvantage following the pandemic.

The pandemic is also driving changes in how we all live and work, which in turn are likely to permanently alter the structure of the economy. Not all firms and workers will return to the same activities they carried out at the start of the year. Some firms will close and some jobs will not return. There may also be permanent shifts in consumer preferences, which will change how Australians work, shop and travel. COVID-19 is already changing global trade patterns and supply chains. It is also increasing the uptake of digital technology, with more Australians adopting flexible work arrangements.

The COVID-19 pandemic is projected to lower Australia’s potential output growth in the near term, by affecting all three supply-side drivers of growth: population, participation and productivity. Working-age population growth and the trend participation rate are now both expected to be lower over the medium term than was expected in the 2019-20 MYEFO due to lower net overseas migration. In addition, weakness in business investment will lower growth in the capital stock and in turn labour productivity. Potential GDP growth is estimated to fall below 2 per cent per annum in the near term before gradually returning to 2¾ per cent towards the end of the medium-term projection period (see Budget Statement 2: Economic Outlook).

Only by creating a more flexible and dynamic economy, that allows capital and labour to shift to growing firms and sectors, and investing in our productive capacity, will Australia achieve the strong economic growth needed over the longer term to build prosperity, reduce debt and respond to future economic shocks. The JobMaker Plan addresses this challenge by supporting the economy in the near term, as well as lifting Australia’s productivity and creating jobs over the medium term.

Supporting aggregate demand to create jobsThe Government will provide assistance to Australian households through the tax system. This includes personal income tax cuts that will increase the

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disposable income of Australians, allowing them to spend more to support aggregate consumption and lift business confidence. This will create opportunities for businesses to increase hiring and undertake further investment, supporting the economic recovery.

Major new investments in infrastructure, transport and water — including major projects like Inland Rail, the Western Sydney Airport and the $484 million Dungowan Dam project — will support jobs, improve connectivity, promote private investment, increase resilience and boost the long-run productive capacity of the economy. Bringing forward investments in energy infrastructure, including projects like Marinus Link, VNI West and Project Energy Connect, will also help Australian families and business have access to reliable, affordable energy.

Supporting business to create jobsIncreased business investment is important for building up a larger and higher quality stock of capital across the economy, making businesses more efficient and workers more productive. The Government has already assisted businesses by increasing the instant asset write-off threshold and through the Backing Business Investment measure. The JobMaker Plan expands on this support by allowing full immediate expensing of depreciable assets for 3.5 million eligible businesses (over 99 per cent of all businesses) and through the loss carry-back measure.

The crisis is driving a significant reallocation of capital and labour resources across the economy. The JobMaker Plan will enable businesses and workers to fully engage in the most productive activities, maximising the returns on investments in physical and human capital.

Central to this is the Government’s deregulation agenda. Streamlining approvals for major projects, through reforms under the Environment Protection and Biodiversity Conservation Act, and National Cabinet’s priority to automatically recognise occupational licences across borders will make it easier for businesses to invest and attract skilled workers. Major changes to Australia’s corporate insolvency system will also cut the costs of doing business and support economic and jobs growth.

Maintaining an open economy and giving Australian exporters greater access to global markets are also key to lifting incomes and building economic resilience. More than 70 per cent of Australia’s two-way trade is now covered by export agreements, up from 26 per cent in 2012-13, while negotiations on a free trade agreement with the European Union and the United Kingdom continue.

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Budget Paper No. 1

Supporting Australians back into jobsThe JobMaker Plan will also help to create a more highly skilled and flexible workforce, boosting human capital and further lifting productivity.

The JobMaker Hiring Credit will help to accelerate growth in employment by giving businesses incentives to take on additional employees that are aged 16 to 35 years old. This will help young people access job opportunities and rebuild their connection to the labour force as the economy recovers from the COVID-19 pandemic. A new $1 billion JobTrainer fund will give hundreds of thousands of Australians access to new skills by retraining and upskilling them into ‘in-demand’ sectors. The Government will also spend $252 million to support the delivery of 50,000 higher education short courses in areas such as teaching, health, science, information technology and agriculture.

Opportunities for Australian industriesThe JobMaker Plan also includes substantial investments in critical sectors. The Government’s manufacturing strategy will build scale and capture income in high-value areas of manufacturing where Australia either has established competitive strength or emerging priorities. It will support our manufacturing sector to be even more productive and highly-skilled, collaborative and at the leading edge of R&D, commercialisation and technology adoption. Likewise, the JobMaker Digital Business Plan will move Australia closer to the goal of being a leading digital economy by 2030 and help to position our industries and universities at the cutting edge of innovation, in a more dynamic and competitive world.

By creating a more dynamic and flexible economy and boosting human and physical capital, the JobMaker Plan will help to deliver a stronger and more resilient economy and hence a stronger budget position over the medium term.

The impact of the Government’s economic support Treasury analysis indicates that Government economic support measures since the onset of the pandemic, totalling $257 billion, are expected to result in economic activity being 4½ per cent higher by 2021-22 and the peak of the unemployment rate being lower by around 5 percentage points than what otherwise would have occurred (Chart 1). Without the Government’s economic support, the unemployment rate would have risen, and remained, above 12 per cent throughout 2020-21 and 2021-22 (Chart 2).

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Statement 4: Fiscal Policy and Economic Growth

Chart 1: Real GDP Chart 2: Unemployment rate

Source: ABS Australian National Accounts: National Income, Expenditure and Product and Treasury.

Source: ABS Labour Force, Australia and Treasury.

The impact of the Government’s economic support measures since the onset of the pandemic has been estimated using Treasury’s macroeconometric model of the Australian economy and detailed bottom up analysis of the direct effect of individual measures.3

In addition to direct effects, there are substantial indirect effects, including on business and household confidence, business solvency and liquidity, and spillovers to other economic activity. These indirect effects continue to build over time. This is consistent with international evidence that fiscal policy is likely to be more effective when there are large amounts of spare capacity in the economy (especially as restrictions are progressively removed) and when monetary policy is close to the zero lower bound.4

Implications of COVID-19 for the fiscal outlook The COVID-19 pandemic has reshaped Australia’s economic and fiscal outlook.

In the near term, spending has increased rapidly as the Government has taken unprecedented action to support businesses and households. As a result of the COVID-19 pandemic, payments in 2020-21 are now forecast to be $677.4 billion, over 30 per cent higher than the levels forecast before the pandemic.

3 This analysis is contingent on assumptions that underpin the forecasts about the spread of the virus, industry containment measures, physical distancing, when a vaccine will become available, and the forecasts of the evolution of the domestic and international economies.

4 See discussion in Ramey VA (2019), ‘Ten Years After the Financial Crisis: What Have We Learned From the Renaissance in Fiscal Research?’, Journal of Economic Perspectives, vol. 33(2), pp. 89-114.

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This increase in the level of payments has been driven primarily by the Government’s targeted and temporary support measures rather than structural changes to the composition of payments. As a result, the level of payments is expected to decline and, over the medium term, broadly return to levels projected at the 2019-20 MYEFO as the economy recovers and temporary support measures are gradually withdrawn.

At the same time, receipts have fallen. In 2020-21 they are estimated to be $463.8 billion, around 10 per cent below the level estimated before the pandemic. This fall in receipts has been driven primarily by the slowing economy, with weaker household income, consumption and capital gains lowering tax receipts.

The Government’s temporary full expensing and loss carry-back measures, which will bring forward capital deductions and the utilisation of losses, will help to boost business cash flows and investment in the recovery phase. They will also speed the recovery of company tax receipts at the start of the medium term (Box 1).

Box 1: Government investment incentives contributing to recoveryThe Government’s temporary full expensing and loss carry-back policies will boost firms’ cash flows and encourage investment. In doing so they will also contribute to the operation of the tax system as an automatic stabiliser. Full expensing will bring forward the timing of tax deductions for investment in depreciating assets, while loss carry-back will bring forward the utilisation of tax losses. In both cases this will reduce the tax burden on businesses while the policies are in force and reduce the amount of tax assets (tax losses and undepreciated asset values) that are carried forward. The effect on tax revenue is a reduction during the pandemic and recovery period, and an increase after the recovery period. Overall, more of the impact of the pandemic on revenue will be realised in the near term due to the reduction in the level of tax assets that are carried forward after the economy has recovered. Furthermore, these incentives will contribute to the recovery by encouraging firms to undertake investment before the time-limited policies end. Finally, loss carry-back complements full expensing by preserving the bring-forward of tax asset recognition for firms that experience a tax loss due to the deductions generated by full expensing. without loss carry-back these benefits would not be realised until the business returns to profit.

The fiscal impact of COVID-19 will persist across the medium term. Lower population growth from lower net overseas migration during the COVID-19 pandemic will continue to weigh on the economy. Australia’s economy will be persistently smaller as a result of the COVID-19 pandemic, relative to

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previous forecasts. While growth is expected to recover strongly as restrictions are eased, this will come from a smaller base. By the end of the forward estimates, the level of nominal GDP is expected to be around 7 per cent lower compared with the 2019-20 MYEFO, with this gap gradually widening to around 8 per cent by the end of the medium term.

Spending as a share of GDP will be higher than previously projected across the medium term, predominantly as a result of the smaller nominal economy. At the 2019-20 MYEFO, spending was projected to trend downwards to around 23.6 per cent of GDP by the end of the medium term. In this Budget, spending is still expected to trend downwards, but to 26.2 per cent of GDP at the end of the medium term, around 2½ percentage points higher than previously forecast.

While the rate of growth in prices and wages is forecast to recover to pre-crisis rates, the levels are expected to remain lower than was projected at the 2019-20 MYEFO. Given Australia’s progressive personal income tax system, lower nominal wage levels will reduce average tax rates and taxation receipts as a share of the economy. By the end of the medium term, the tax-to-GDP ratio is projected to reach 22.9 per cent, around 1 percentage point lower than expected at the 2019-20 MYEFO.

As a result of the persistent gap between spending and receipts, the underlying cash deficit is projected to still be around 1½ per cent of GDP at the end of the medium term, despite the temporary economic support being unwound.

Estimates of the structural budget balance paint a similar picture of the lasting impact of the pandemic on Australia’s fiscal position. Structural budget balance estimates attempt to remove temporary movements in receipts and payments. The cause of these shifts include deviations in real GDP, commodity prices, asset prices and the rate of unemployment from their long-run trends, as well as discretionary fiscal measures. Considered in conjunction with other measures, estimates of the structural budget balance can provide broad insights into the sustainability of fiscal settings.

Updated estimates show that there was a persistent structural budget deficit following the Global Financial Crisis, partly reflecting the long-lasting impact of the crisis on tax receipts as a share of GDP. While the structural budget position was estimated to move into a sustained surplus from 2021-22 at the 2019-20 MYEFO, the latest estimates now suggest an ongoing structural budget deficit of around 1½ per cent of GDP by 2030-31 (Chart 3). This reflects the higher payments-to-GDP ratio as well as lower projected tax receipts as a share of GDP over the medium term.

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Budget Paper No. 1

In the near term, the large temporary economic support measures and cyclical factors (including the automatic stabilisers) make significant contributions to the deterioration in the underlying cash balance.

Compared with the 2019-20 MYEFO the projected structural budget balance in 2029-30 has deteriorated by 3½ per cent of GDP. Around 2½ percentage points of this structural deterioration is due to higher payments as a share of GDP. The remaining 1 percentage point reflects lower tax and other receipts as a share of GDP.

Chart 3: Structural budget balance

Note: The presentation of the structural budget balance chart has been adjusted to separate the budgetary impact of temporary discretionary measures from structural factors. This approach follows the methodology detailed in Treasury Working Paper 2013-01. ‘Discretionary measures’ comprise the total COVID-19 Response Package, and the full expensing, loss carry-back, personal income tax reductions and hiring credit components of the JobMaker Plan. The ‘cyclical factors’ component comprises the estimated impact on the underlying cash balance of automatic stabilisers and cyclical movements in asset and commodity prices. Source: Treasury.

Fiscal sustainability after COVID-19The 2019-20 MYEFO forecast that Australia’s net debt would be 19.5 per cent of GDP ($392.3 billion) at the end of 2019-20. This was projected to decline to 1.8 per cent of GDP ($59.8 billion) at the end of 2029-30.

Lower receipts and additional spending in response to the COVID-19 pandemic have resulted in a sharp rise in debt. Gross debt is projected to stabilise at around 55 per cent of GDP in the medium term. Net debt is expected to increase from 36.1 per cent of GDP at 30 June 2021 to peak at

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Statement 4: Fiscal Policy and Economic Growth

43.8 per cent at 30 June 2024 before declining to 39.6 per cent of GDP by the end of the medium term.

While Australia’s debt-to-GDP ratio will be higher than we are accustomed to, it remains sustainable. Current and projected debt levels would enable additional targeted and temporary fiscal support measures being adopted should they be required.

Australia entered the crisis with debt as a share of GDP lower in comparison to most other advanced economies. While our debt-to-GDP ratio will increase as a result of the pandemic, the IMF’s June 2020 World Economic Outlook Update indicates that it will remain low compared with most advanced economies (Chart 4).

Chart 4: International comparisons of gross debt as a share of GDP

Note: Gross debt data are for the general government sector, which includes debt issued by sub-national governments where applicable. The range has been calculated using a subset of advanced economies — Canada, France, Germany, Italy, Japan, Republic of Korea, Spain, United Kingdom and United States. These are the only countries for which the IMF provided updated public debt projections in its June 2020 WEO Update. The advanced economy line is a weighted average of the IMF’s advanced economy grouping. Source: IMF World Economic Outlook Update, June 2020 and Treasury calculations.

Debt sustainability will also be assisted by historically low interest rates. Borrowing costs are expected to remain low for some time, making it easier to service debt than in the past (Chart 5).

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Chart 5: Yields on 10-year government bonds

Source: Bloomberg.

Australia’s future growth trajectory will play an important role in debt sustainability. Strong economic growth makes it easier to service debt by directly expanding the size of the economy relative to the amount of outstanding debt. Holding other factors constant, the debt-to-GDP ratio will fall when nominal GDP increases.

As Box 2 explains, a smaller fiscal adjustment is required to stabilise and then reduce debt as a share of GDP when the economy is growing and interest rates are low. When growth is sufficiently high and borrowing costs sufficiently low, it is possible to reduce debt as a share of GDP, even without running budget surpluses. This is evident over the projection period, where nominal GDP growth makes a significant contribution to stabilising the debt-to-GDP ratio (see Box 2).

Lifting economic growth will also improve Australia’s fiscal position by allowing the Government to transition away from temporary support measures more quickly and because a stronger economy drives higher profits and wages, boosting tax receipts and reducing spending.

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Box 2: Understanding fiscal sustainability and debt dynamics A minimum requirement for fiscal sustainability is that, on average, obligations grow in line with the capacity for the government to raise revenue. Because tax receipts are closely aligned with nominal GDP, the debt-to-GDP ratio is the appropriate measure of debt to use when analysing fiscal sustainability, rather than the dollar value of debt. Changes in the debt-to-GDP ratio reflect changes in the ‘primary balance’ (the difference between receipts and non-interest spending), the difference between borrowing costs and the economic growth effect, and a residual that consists of net Future Fund earnings, proceeds from asset sales or outflows from investments, and other accounting factors that affect the measurement of debt (Chart 2A).

Chart 2A: Contributions to changes in gross debt as a share of GDP

Source: Treasury.

In order to achieve a stable debt-to-GDP ratio, the primary balance only needs to be high enough to exactly offset the gap between borrowing costs and the growth effect. To reduce the debt-to-GDP ratio, these primary balances need to be high enough to more than offset the gap between borrowing costs and the growth effect. The primary balance does not necessarily need to be in surplus in either case. It is possible to reduce the debt-to-GDP ratio with a small primary deficit if the growth effect is greater than the borrowing cost. Other things equal, historically low interest rates, if maintained, mean that the government can stabilise and then reduce the debt-to-GDP ratio with smaller primary balances than have been required in the past.

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As the economy recovers, it will be prudent to stabilise and then reduce debt levels over time. This will provide fiscal space to accommodate long-term budgetary pressures and rebuild our fiscal buffers in order to provide support in the event of future shocks. Historical experience shows that the budget position can deteriorate substantially in response to shocks and takes many years to recover (see Chart 6). In part, this reflects the long-lasting impact that a recession can have on the labour market and earnings. Notably, Australia’s unemployment rate has typically risen twice as fast as it has fallen. This underscores the importance of the Government’s focus on securing a strong recovery to limit the long-term effects of the crisis on firms and workers.

Chart 6: Gross debt and unemployment

Source: ABS Labour Force, Australia and Treasury.

Revised Economic and Fiscal Strategy In response to the COVID-19 pandemic, the Government has revised its Economic and Fiscal Strategy (see Budget Statement 3: Fiscal Strategy and Outlook).

Prior to the COVID-19 pandemic, the fiscal strategy was focused on: investing in a stronger economy to boost productivity and workplace participation; maintaining strong fiscal discipline and containing the size of government; and building to budget surpluses of at least 1 per cent of GDP as economic circumstances permitted. The Government’s objective was to deliver budget surpluses of sufficient size to significantly reduce gross debt and eliminate net debt by the end of the medium term.

The nature of the COVID-19 shock means that this is no longer an appropriate course of action. It would now be damaging to the economy and

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unrealistic to target surpluses over the forward estimates, and would risk undermining the economic recovery needed to underpin a stronger medium-term fiscal position.

The revised strategy consists of two phases. The first phase is focused on achieving a strong economic recovery to drive down unemployment and will be delivered through both the ongoing COVID-19 Economic Response and the JobMaker Plan.

During the first phase, the Government will provide continued support for aggregate demand while introducing important longer-term supply-side and structural reforms through the JobMaker Plan to boost growth and increase our economy’s potential output. The Government will allow the automatic stabilisers to work freely to support the economy while continuing to provide temporary, proportionate and targeted fiscal support to incentivise private sector investment to drive productivity and create jobs.

Once the recovery is assured, with the unemployment rate comfortably back under 6 per cent, the Government will shift to the second phase of the strategy. Waiting until the unemployment rate is back below 6 per cent will ensure that economic support is not withdrawn prematurely, helping to prevent economic scarring and increases in long-term unemployment. After the 1990s recession, it took around 2 years for GDP to return to previous levels. However, it took 10 years before the unemployment rate fell back below 6 per cent. Based on current forecasts, the unemployment rate is expected to reach 6 per cent by the June quarter 2023 and 5½ per cent by the June quarter 2024.

The second phase — the medium-term fiscal strategy — will focus on stabilising and then reducing gross debt and net debt as a share of GDP.

The revised Economic and Fiscal Strategy maintains some themes of the previous fiscal strategy. These include a commitment to maintain fiscal discipline through temporary and targeted measures that do not undermine the Budget’s structural position, a commitment to keeping the burden of taxation equal to or lower than 23.9 per cent of GDP, and ensuring the delivery of essential services by maintaining the quality and efficiency of government spending.

It also retains, and increases, the focus on economic growth as the key plank of the Government’s strategy for budget repair. The JobMaker Plan is central to this strategy.

The revised Economic and Fiscal Strategy will support a strong economic recovery through the JobMaker Plan and help create a more dynamic

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Budget Paper No. 1

economy to deliver economic growth and fiscal sustainability into the future.

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